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Functions Governing the Devolution of Fiscal Powers under a Federal Structure

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Functions Governing the Devolution of Fiscal Powers under a Federal Structure!

The theory and practice of the devolution of powers and function among the different tiers of government involved in the fiscal operation is what is called as ‘fiscal federalism’.

In other words, fiscal federalism provides a framework for the devolution of function between the national and the sub-national government along with a framework for sharing the revenue collected among the different tiers of government.

Allocation Function:

The task of ensuring the welfare of its people requires a government to devise a system by which the allocation of public goods and services are efficiently made. An important question in this context is-which tier of government should provide which type of services.

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A widely followed principle, in this respect, is that of ‘benefit incidence’. Benefit incidence is a method of computing the distribution of public expenditure across different demographic group, such as women and men.

The procedure involves allocating per unit public subsidies (for example, expenditure per student for the education sector) according to the individual utilisation rate of public services. Further, according to the benefit incidence principle if there is a function whose benefit is nation-wide, such a function is to be entrusted to the national government, while if the benefit of a function is regional or sub- regional in character such a function should be entrusted to the State or local governments.

Thus, services like defence, scientific exploration, etc. whose benefit incidence reaches the whole nation, should be provided by the Central government. On the other hand, public goods like law and order, supply of water, electricity, sanitation, etc. state and local level governments.

Distribution Function:

Distribution of services, and therefore the resources to be raised by levying taxes for providing the services to the people, is another important fiscal function. The function of distribution is assigned to the Central government. If this function is to be carried out by the sub-central governments, it may lead to distortions in the mobility of labour leading to increase in inequality.

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The distribution process by the State and local level governments becoming a failure is that these tiers may choose to implement the distribution process for reasons of politico-administrative factors. However, this does not mean that the sub-Central governments cannot altogether render the distribution function.

It also does not mean that the Central government is always more capable and effective in discharging the distribution function. It only means that the Central government may have a greater reach and act in the national interest than the sub-Central government in many cases.

Stabilisation Function:

The process of aiding macro-economic adjustment is known as ‘stabilisation’. Stabilisation function cannot, however, be entirely entrusted to sub-central government as they do not have adequate instruments to deal with such macro-economic issues without giving scope for economic distortion. Moreover, in most of the federations, it is the exclusive prerogative of the Central governments to deal with the ‘external sector’.

In view of this, in almost all the federations the Central government performs the function of stabilisation by using the tools of monetary and fiscal policies. Thus, while the Central government has an absolute advantage in rendering the redistribution and stabilisation functions, lower layers of government can render the function of delivery of goods and services more effectively.

In the light of these, while functional responsibilities have been distributed between different layers of government on the basis of the principle of benefit incidence, functions like defence, space, exploration, navigation railways etc. have been entrusted to the central government. Functions like law and order, water supply, education, health, sanitation, agriculture, etc. are entrusted to the lower tiers of governments.

Once the functional division takes place, each tier of government needs financial resources to discharge their respective functions. So what is equally important is the distribution of revenue or tax powers.